BofA US Rates Watch: Foreign demand faces more headwinds

Key Views

Japanese government discussions around encouraging GPIF and public pension funds to increase domestic asset allocation could divert future rebalancing demand away from foreign bonds—US Treasuries in particular. Foreign official custody holdings have fallen over $180 billion since mid-February, only partly explained by intervention liquidity preparation and likely reflecting ongoing dollar asset diversification.

On the supportive side, US fixed-income fund inflows have accelerated, led by aggregate bond and long-duration government funds, helping absorb supply. However, investment-grade corporate issuance continues to compete for duration. At auctions, investment fund participation remains robust with low dealer shares, yet foreign allocations have dropped below 20%, confirming demand structure divergence.

Outlook

BofA forecasts core CPI at 0.28% month-over-month, above consensus. If realized, July rate-hike probability could approach 50%. Stronger data risks triggering additional selling, especially as CTA trend signals reinforce bearish momentum.

Recommended Securities

• Short 2-year Treasury: Stronger inflation and retail data should push front-end yields higher.
• 2s10s curve flattener: A more hawkish Fed would pressure the front end, though foreign long-end demand weakness requires volatility management.

Key exhibits

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